Last week an administration that wanted a weaker dollar for trade purposes found itself using up its foreign exchange reserves in a currency intervention to prop up the value of the dollar. The dollar's fall forced up interest rates as people sold U.S. bonds to avoid the currency loss, and it was the rising interest rates that forced the administration to back the dollar.
President Clinton's economic strategy is based on low interest rates, and the dollar's fall was threatening that strategy. The dollar almost fell below 100 Japanese yen. If it had, widespread selling of dollars would have set off a slide that could have reached panic proportions.The intervention was helpful because it made the point that the administration had changed its mind about wanting a weaker dollar. But central bank reserves are small compared to the daily transactions in currency markets. The dollar was stabilized by the expectation that the Federal Reserve will soon raise interest rates by half a point. This is seen as a necessary measure to slow the growth of the money supply so that the dollar is not pushed down by the threat of inflation.
Since Clinton has been president, tax rates have gone up, interest rates have gone up, the price of gold has gone up, and the exchange value of the dollar has fallen. None of this spells prosperity, but it is all related.
Clinton started off on the wrong foot. By raising taxes he sent a signal that the needs of the government come first. This discouraged some investors, who moved some of their capital abroad where they saw more opportunity.
Bank regulation and monetary policy have also worked to Clinton's disadvantage. In an effort to revive the economy, the Federal Reserve pumped a lot of money into banks. But the banks were under such regulatory pressures that they were afraid to lend. Instead, they bought government bonds. Initially, this lowered interest rates, but it didn't fuel a business recovery.
The economy was so slow to recover that the Federal Reserve overdid the easy money and laid a basis for inflation once the economy picked up. This is the threat that has been sending the dollar down and interest rates up.
For Clinton, all of this means trouble. He raised taxes, relying on low interest rates to move the economy along. But interest rates have gone up, too, and now the Federal Reserve will have to push them higher in order to tighten up on the money supply.
Higher taxes, higher interest rates, tighter money, and falling confidence in the president cloud the outlook for a sustained economic recovery.
Clinton's approach is defective, because it relies on expanding government and shrinking the private sector with taxes. His reforms, such as welfare reform and health-care reform, require the expenditure of vast sums of money necessitating higher taxes. Even the crime bill greatly expands the federal government.
If Clinton's welfare reform were real reform, it would require less money, not more. His health-care reform turns medicine into a government bureaucracy. We will pay more, but doctors will get less, and the government's income tax revenues will fall, thus pushing up the deficit.
The economy is much more complicated than Clinton imagines - and that's why the dollar and the economic recovery are running into trouble.